Bank loan gives senior big problems

David Meal, 72, walked into his local bank in October 1999 and asked for a $90,000 loan. He intended to invest it and his $10,000 in savings in the bank’s NASDAQ index mutual fund.Bank officials approved the loan and accepted his buy order. Later, they also took his order to switch his investment to the bank’s global technology fund.When the technology sector tanked in 2001, the value of Meal’s investment plummeted. He soon found himself on the hook for the full amount of the loan, plus the value of the fund distributions, which had been reinvested automatically.

According to the investment dispute consultant he has hired, Meal owes the bank more than $130,000.

Fears losing home
A pensioner of modest means and poor health, he and his wife now live in fear of losing their home.
Who’s to blame for this mess?

From a distance, Meal himself. He was greedy, had unreasonable expectations and suffered from his own imprudence.

But a closer look reveals additional culprits in this financial disaster.

The way in which the bank failed him underscores urgent problems forhe whole industry.

Know the client
Suitability is a cornerstone of investment advice. The know-your-client rule obligates investment professionals to learn the essential facts about each of their clients and to consider every transaction in this light.

It seems this rule was not applied in Meal’s case. Otherwise, how could such a high-risk strategy—he leveraged his investment by 10 times—applied to a notoriously volatile sector, be deemed a “suitable investment” for a 70-plus man with few assets and minimal income?

Conflict of interest
And here’s something even more troubling. In granting Meal the loan and selling him the fund, the bank positioned itself in a conflict of interest.

Doing both dangerously blurred the line between lender and seller/adviser as provider of independent, unbiased advice.

It wasn’t that long ago that banks didn’t sell mutual funds, just as investment dealers didn’t offer insurance to their clients, and insurance salespeople didn’t deal in securities.

Next page: Downside of deregulation

Downside of deregulation
We applauded as the 1980s saw the once-separate pillars of the financial industry crumble. Thanks to deregulation, consumers would benefit from greater competition and more convenience.But in our enthusiasm, many of us overlooked the ticking time bomb of lax regulation.

As early as 1995, Glorianne Stromberg, then a commissioner with the Ontario Securities Commission, identified the urgent need for reform in a burgeoning fund industry.

She also pinpointed the “fusion of product, function and advice” as a pivotal issue for consumer protection—an uncanny foreshadowing of Meal’s predicament.

Reform urgently needed
Change has been slow. We have a jumble of provincial/territorial rules with watchdogs for various industry sectors.

Outdated structures make for an unworkable system that leaves investors confused about who does what—and vulnerable to abuse by knowledgeable professionals.

It’s unlikely that David Meal’s situation is unique, though its magnitude is alarming. Through his misfortune, we should be reminded that, tempting as it is, leveraged borrowing can be a terribly risky strategy with potentially disastrous results.

For regulators, it should be a loud wake-up call. The success of the financial industry depends on building and holding investor confidence through fair rules and fair treatment.

Both seem sadly lacking in this case.

David Tafler, publisher of CARPNews FiftyPlus, is an author and commentator on financial planning. June Yee, financial editor of CARPNews FiftyPlus, edits books and newsletters on personal finances.